Overview:
Asset classification refers to the process by which banks and financial institutions categorize their loans and advances based on the level of credit risk and potential default. This classification is crucial for determining appropriate provisioning—i.e., the amount banks must set aside from their profits to cover potential loan losses. Adequate provisioning ensures financial stability and a healthy balance sheet, especially in the presence of Non-Performing Assets (NPAs).
1. Asset Classification Categories
- Standard Assets: Loans and advances where interest and principal payments are current and no default has occurred.
- Substandard Assets: Loans where interest or principal has remained overdue for more than 90 days.
- Doubtful Assets: Assets that have remained in the substandard category for 12 months or more.
- Loss Assets: Loans where the loss has been identified either by the bank or external auditors, and the outstanding amount is deemed uncollectible.
2. Provisioning Requirements by Asset Class
In line with prudential norms, banks must provide for potential losses based on asset classification as follows:
A. Standard Assets
| Asset Type | Provision Requirement |
| Agriculture & Small and Medium Enterprises (SMEs) | 0.25% |
| Commercial Real Estate (CRE) | 1.00% |
| Housing Loans (Teaser Rate Period) | 2.00% during teaser rate period |
| Housing Loans (After 1 year of rate reset) | 0.40% |
| Restructured Advances (first 2 years from restructuring) | 2.00% |
| Restructured NPAs (first 5 years from upgradation) | 2.00% |
| Under Moratorium | 2.00% during moratorium + 2 years (Total 4 years) |
B. Substandard Assets
| Loan Type | Provision Requirement |
| All Sectors (without security/ECGC cover) | 15% of outstanding amount |
| Unsecured Advances | Additional 10% (Total 25%) |
| Infrastructure Loans (with escrow) | Total 20% |
C. Doubtful Assets
| Loan Tenure (Secured Portion) | Provision Requirement |
| Up to 1 year | 25% |
| 1 to 3 years | 40% |
| More than 3 years | 100% |
| Unsecured Portion | 100% |
For ECGC-covered loans, provisioning is required only on the balance in excess of the guaranteed amount, after deducting the realizable value of the security.
D. Loss Assets
| Loan Type | Provision Requirement |
| All Loans | 100% of outstanding amount or write-off |
3. Provisioning Coverage Ratio (PCR)
Provisioning Coverage Ratio (PCR) is the ratio of provisioning to gross NPAs and indicates the extent of funds reserved for loan losses. Banks must maintain a PCR of at least 70%, including floating provisions. This requirement aligns with Basel Accords (Basel I, II, and III), which advocate for robust provisioning to safeguard financial stability.
4. Special Provisioning Circumstances
- Rehabilitation Packages (BIFR/TL Institutions):
Provisioning continues as per asset classification (substandard/doubtful). For additional facilities under the package, provisioning is required for one year from the date of disbursement, including for Small Scale Industries (SSI) identified as sick. - Assets Covered by TDRs, NSCs, IVPs, KVPs, Gold, Government and Other Securities, LIC Policies:
Provision must be made for any shortfall beyond the realizable value of securities (100% provision on the excess). - Interest Suspense Account:
The amount in the Interest Suspense Account must be deducted from the outstanding advance before calculating provisioning. This amount is not considered part of the bank’s provisions. - ECGC-Guaranteed Doubtful Assets:
Provisioning is only required on the balance after deducting the ECGC guarantee and realizable value of security from the outstanding amount.
5. Disclosure Requirements
Banks are obligated to disclose any divergence in asset classification and provisioning that exceeds prescribed thresholds, as per regulatory guidelines. Transparency in disclosures ensures accountability and strengthens stakeholder confidence.
Conclusion
Asset classification and provisioning norms are foundational to prudent risk management in banks. These norms ensure that credit risk is appropriately recognized and mitigated, contributing to the overall health and stability of the financial system.
Disclaimer:
The information presented is for educational purposes only and is based on publicly available sources, which may be subject to change. The author assumes no responsibility for any direct or indirect loss incurred by readers based on this information. Readers are advised to consult a qualified financial advisor before making any financial or investment decisions.
